Tuesday, April 24, 2012

The Fed needs to move quickly on Maiden Lane III CMBS asset sale

IFR/Reuters published an article yesterday on a group of banks bidding for the commercial real estate assets of Maiden Lane III (one of the two AIG rescue facilities). Not to be outdone, Bloomberg/Businessweek did their own story today. It's important to note (IFR didn't make it clear) that the bid is only for the CMBS portion of the portfolio (two CDOs).

Source: NY Fed

IFR/Reuters: - Citi, Goldman and Credit Suisse are joining forces to submit a combined bid for the bonds, which they believe will be more competitive than acting individually, sources familiar with the plan said on Monday.

The debt in the Maiden Lane III portfolio is known as the MAX CDOS, and the deals were originally arranged by Deutsche Bank.

Blackrock, who is managing this portfolio has been criticized for not extracting the full value for the Fed by entertaining this group bid.

IFR/Reuters: - “If Blackrock really wanted to recoup maximum proceeds for the taxpayer, they’d look into collapsing the CDO themselves, and auctioning off the individual bonds,” said Adam Murphy, president of Empirasign Strategies in New York, which tracks trading in securitized debt.

"Collapsing the CDO" however is easier said than done. In order to sell the underlying portfolio of CMBS securities held as collateral in the two CDO structures, one needs to control the CDO liabilities.

IFR/Reuters: Deutsche Bank already owns junior tranches of the collateralized debt obligation (CDO) on offer and if it also purchases the senior parts it may hold majority ownership in the structure.

Therefore whoever wants to sell off the individual bonds first needs to buy the junior tranches from Deutsche. But that wouldn't be the end of it. There is also a rate swap (which has seniority in such deals) that needs to be terminated with Barclays before collateral could be unlocked.

Businessweek: - The CDOs could be sold intact or broken into pieces. An interest-rate swap contract with Barclays would need to be paid out to access the underlying bonds, eating into profits, according to JPMorgan Chase & Co. (JPM) (JPM) Deutsche Bank, which owns the most junior slices of the CDOs, would need to be bought out to break up the CDO, according to people familiar with the deals.

Barclays (actually the old Lehman people) even suggested that instead of selling the collateral, they would actually "re-tranche" the CDO to make the senior tranches better quality (more subordination) - "putting the humpty dumpty together again". That may make these bonds more attractive to institutional buyers, but would take time.

The Fed's exposure to Maiden Lane III has been declining as the interest payments from the deal are used to pay down the original loan against the facility.

Source: NY Fed

Once that's paid off, AIG gets its loan paid and the remaining cash flows are all profit for the Fed (shared in part with AIG). However it is important for the Fed to move quickly. Here are the reasons.

1. Trying to sell the collateral may not necessarily get the best price because the Fed/Blackrock would be dribbling out 103 separate CMBS bonds. That in turn could push down the market for this type of paper and may even spill over into other markets as was the case with Maiden Lane II. And to unlock the collateral, deals would need to be struck with Barclays and Deutsche. These negotiations may take more time.

2. Under the Volcker rule and with Basle III, the dealers will be allowed to hold far less inventory, making it much more difficult for them to take down a big slug of structured credit paper. It would be easier to do this trade before these new regulations are in place.

3. If we have another major market disruption driven by events in Europe, nobody is going to touch this paper for a while.

4. There is a risk that the US economy takes a turn for the worse. That would put further pressure on the commercial property markets, potentially impairing more of the CMBS paper.

The sooner the Fed unloads this wonderful portfolio the better. Because next on the sell list, after the CMBS CDOs, are the Maiden Lane III ABS CDO bonds of much greater size.